One of the areas of financial regulatory reform which the financial services industry is focusing a considerable amount of effort on is federal preemption of consumer protection law. As the Obama administration proposed it, financial reform would set a floor for consumer protection regulations, which individual states could then add onto if they felt the need to go further. This would give states the flexibility to address particular consumer abuses before they spread to other parts of the country.
Banks, however, want federal regulations to preempt state law, which would enable them to focus on weakening regulation at the federal level, while rendering the states powerless to do anything about it. During the buildup of the subprime lending bubble, several states tried to more aggressively police predatory mortgage practices — particularly in 2002 and 2003 — but they were repeatedly preempted by the federal regulators, until ultimately the bubble burst.
This week, Treasury Secretary Tim Geithner emphasized that states will have a “crucial role” in policing predatory lending. But already, the regulatory reform bill passed by the Senate Banking Committee gives regulators the option of preempting state law on a case-by-case basis, and the banking lobby is pushing for complete and total preemption. So was Geithner saying that the Senate needs to take a stand here?
Via Marcus Baram, the University of North Carolina’s Center for Community Capital has two new studies, which should be very helpful for this debate. The first found that anti-predatory lending laws (APLs) resulted in better mortgage loans and fewer foreclosures:
At the loan-level, state APLs are found to be associated with a 13 percent reduction in prepayment penalties and may also reduce the incidence of option adjustable-rate mortgages (ARMs). These laws also reduced the likelihood of a loan becoming 90+ days delinquent by 13 percent. At the neighborhood-level, the presence of an APL is found to reduce the foreclosure rate up to 18 percent.
The second study looked specifically at laws that were preempted by the Office of the Comptroller of the Currency, and found that “preemption resulted both in deterioration in the quality of and in the increased default risk for mortgages”:
More narrowly, they show that OCC-preempted lenders increased their share of loans originated with risky subprime characteristics. Similarly, they show that loans originated by OCC-preempted lenders were more likely to default in APL states after the OCC preemption. Finally, the results show that in the refinance market the increase in default risk among OCC lenders often outpaced that of independent mortgage companies that remained subject to stronger APLs after 2004.
“Our research confirms that state consumer protection laws work, but that when one group of lenders is handed a regulatory free pass, they are going to take advantage of it,” said Roberto Quercia, the Center for Community Capital’s Director. Indeed, going forward, any efforts to strengthen preemption and take more power away from the states should be resisted. And if some intrepid congressman wants to try and prevent preemption entirely, as the administration initially proposed, that would be good too.